The Complex Truth About Trading in a Bull Market

We’re back in a bull market, with many of the major indices tipping all-time highs. We all know that during such periods, everyone can look smart. But, after last fall’s swoon, many are treading carefully wondering if it is safe to join the party, or does prudence take precedence and suggest it’s time to take some money off the table?

With that said, now is a good time to review some of the basic tenets, rules, aphorisms and yes, clichés that help guide us — not just through turbulent times but, more importantly — can keep us humble through the bull.

Remember, clichés are clichés because they contain the kernel of truth that makes them useful. So are sports, gambling, and other analogies. Let’s jump right in.

There are many ways to skin a cat just as some poker or tennis players are defensive grinders and while others swing for the fences. So some things that work or are appropriate for me might be antithetical to your style or temperament.

As you can see sometimes things get mixed up or can actually directly contradict each other; this just points out how one needs to keep an open and flexible mindset.

Here are some of the quotes, aphorisms and yes cliches that have helped guide my trading career.

Prepare to Lose: You must be prepared to experience losses, it’s simply part of the game. Depending on your approach, you can control the size and frequency, but losses will happen. This is true, even those that think they have a “system.” Make limiting your drawdown in capital your number one priority, not your profits. It is much easier to be profitable when you don’t lose a lot of money.

Never lose more than 1% of your total trading capital on any one trade. Do not overexpose your account to too many positions that are all closely correlated to the same trend. Only take your highest probability entry signals. Only trade four to five open positions at a time, so even big whipsaws in price action do not damage your account too much

Trade smaller and smaller during losing streaks, and only get back up to full size during winning streaks.

Use option contracts to cap possible maximum losses to only the contract size. Do not become biased as a bull or a bear. Be open-minded to what the markets and your signals are saying about the current trend.

Trade only a method that you fully understand, and don’t piggyback on another trader.

Never buy a stock because it had a big decline from its previous high.

Being reactive instead of predictive on actual price action is a winning principle that I have seen in many rich traders. Letting price action give you signals is trading in reality. Trading based on what the price should be is wishful thinking.

Here are the 7 Deadly Sins:

Hubris: A foolish amount of pride or overconfidence. No matter how good of a trader you think you are, the market is always bigger. You will not win an argument with its price action no matter what.

Gluttony: You’ve had success in your personal account. Don’t think you can scale it up to a multi-billion hedge fund and just get fat on the fees. You’ll get fat in the near term, and then die shortly thereafter when you can’t recreate your results or stand the pressure of trying to do so.

Fear: Cutting winners short because of unwarranted fear eliminates all the big wins. Being afraid to take a good entry creates a loss of a potential profit. Thorough trading methodology study is required to trade confidently.

Ego: The desire to be right more than the desire to make money leads to losing a lot of money. The ego causes traders to hold losers far too long. The best traders are slaves to the market’s price action.

Laziness: Seeking to be given trades instead of doing the work to develop a system leads to failure. Trades only have meaning when they are executed within a robust system complimented by discipline and risk management.

Greed: The greedier a new trader is, the higher the probability and speed at which they lose their whole trading account. There is a significant risk in going for trades with big position sizes because the losses can be huge if when wrong.

Lust: Don’t try to make money as a means of happiness. It won’t work. Am I right guys and girls?

About the Author: Steve Smith

Steve has more than 30 years of investment experience with an expertise in options trading. He’s written for TheStreet.com, Minyanville and currently for Option Sensei. Learn more about Steve’s background, along with links to his most recent articles. More...